QUIC RESEARCH REPORT

January 16, 2017

QUIC RESEARCH REPORT

Consumers & Healthcare

Julie Vincent Jon Allion Andrei Florescu Connor Steckly

Canadian Grocery Market Report A Fresh Look at Some Appetizing Investments

Introduction

The Canadian grocery market makes up the largest segment amongst all food sales in the country. This report will examine major players within the industry, key consumer trends and where current companies in this space are most vulnerable to new competition.

Summary

- The Canadian grocery market is dominated by three major players ("The Big Three") which account for over 50% of total market share ? Loblaw, Metro and Empire

- With the addition of Walmart and Costco's "SuperCentre" stores and Amazon's entrance into the grocery landscape, the "Big Three" key players must adapt to new industry trends

- Metro displays all the right ingredients to be a solid investment. MRU possesses the rare combination of holding solid business characteristics while also showing favourable valuation criteria

- While Loblaw and Empire possess some strong characteristics as well, they are inferior to Metro and do not hold the same level of attractive valuation that Metro does

QUIC Research Reports focus on emerging investment themes that affect current portfolio companies and companies under coverage.

The information in this document is for EDUCATIONAL and NON-COMMERCIAL use only and is not intended to constitute specific legal, accounting, financial or tax advice for any individual. In no event will QUIC, its members or directors, or Queen's University be liable to you or anyone else for any loss or damages whatsoever (including direct, indirect, special, incidental, consequential, exemplary or punitive damages) resulting from the use of this document, or reliance on the information or content found within this document. The information may not be reproduced or republished in any part without the prior written consent of QUIC and Queen's University.

QUIC is not in the business of advising or holding themselves out as being in the business of advising. Many factors may affect the applicability of any statement or comment that appear in our documents to an individual's particular circumstances.

? Queen's University 2016

QUIC Research Report

January 16th, 2017 Canadian Grocery Market Report ? A Fresh Look on Some Appetizing Investments

Table of Contents

Introduction

1

Industry Overview ? The Canadian Grocery Market

3

Loblaw (TSX:L) ? Investment Update

5

Metro (TSX:MRU) ? Investment Mini Pitch

7

Empire (EMP.A) ? Investment Evaluation

7

References

12

January 16th, 2017

QUIC Research Report

January 16th, 2017 Canadian Grocery Market Report ? A Fresh Look on Some Appetizing Investments

Canadian Grocery Market Overview

The grocery store market in Canada encompasses the largest food retail channel in Canada. These establishments retail general lines of food products, including fresh and prepared meats, poultry and seafood, canned and frozen foods, fresh fruits and vegetables and various dairy products.

Within Canada, the three largest competitors in the landscape include Loblaw (TSX:L), Metro (TSX:MRU) and Empire (TSX:EMP.A). Combined the three companies possess nearly three quarters of the entire market share (Loblaw 30%, Empire 25.7% and Metro 10.5%).

further pressured industry operators to lower their product prices.

In recent years some of Canada's top grocers have lost market share to a variety of discount retailers, such as Costco and Walmart which have gained market share of the food-retailing sector through efforts of these mega-chains to bolster their grocery sections.

Key drivers for this industry come from per capita disposable income, consumer price indices for food and external competition from new entrants.

During fiscal year 2016, Canadians spent over $85 billion on groceries, with companies capturing just shy of $2 billion in profits. The industry has grown at an annualised rate of 1.4% in the trailing five years, and analysts expect this rate of growth to persist in years moving forward.

Although industry expansion in recent years, increasing competition from alternative retailers such as warehouse clubs and supercentres and lowered the volume sales of certain goods and

In years moving forward, it is expected that Canadian consumers will have more discretionary income to spend on food shopping. With the consumer price food index expected to grow at a faster rate than discretionary income, this could pose a threat to the industry. Lastly, the threat of new entrants stealing market share from current players should concern all existing grocers in the market. As a result, we believe companies that can adapt to changing consumer trends and those who place freshness over prices should prosper.

EXHIBIT 1 Canadian Grocery Market Product Segmentation

EXHIBIT 2 YoY Revenue Growth for Industry

25% 35%

9%

10%

Dairy, Eggs and Fish Vegetables Bakery Products

Source: IBIS World

10%

January 16th, 2017

11%

Fruit and Nuts Nonfood Items Other Foods

5.8% 1.4%

3.5%

7.0%

3.4%

1.8% 1.5%

(0.4%) (2.0%)

2008 2010 2012 2014 2016

3

QUIC Research Report

January 16th, 2017 Canadian Grocery Market Report ? A Fresh Look on Some Appetizing Investments

Loblaw, Metro and Empire ? Canada's "Big Three"

Loblaw

Loblaw Companies Limited: Loblaw is the largest Canadian holding company and was founded in 1956. Subsidiaries include Loblaw's Inc., Shoppers Drug Mart, Choice Properties Limited Partnership, Choice Properties Real Estate Investment Trust, Joe Fresh and President's Choice Bank. Loblaw Operates 1000 supermarkets and has a total of 22 segment banners. In 2015, Loblaw had revenues of $46B and net income of $623MM.

Metro

Metro: Metro is a Canadian food retailer operating in Quebec and Ontario. It is the third largest food retailer after Loblaw and Sobeys's. They currently own and operate 365 locations as well as 119 discount stores which are operated by Food Basics. In 2016, the company had $1B in sales and was founded in 1947. They have three private labels including Selections, Irresistibles and Super C.

Empire

Empire: Empire Company Limited is a Canadian conglomerate founded in 1963 that is engaged in food retail investments. It's subsidiaries include Sobeys, Crombie REIT, Safeway Canada, Freshco, Foodland and Price Chopper. They have over 40,000 employees and over 500 locations across Canada. In 2015, its total assets were $12.238B and revenue was $21.93B. They are headquartered in Nova Scotia and Fran?ois Vimard is the current interim CEO.

EXHIBIT 3 Key Operating Metrics for the "Big Three"

Loblaw

Market Cap 2016 Return

$28.01B 6.97%

P/E

31.4x

EPS

$2.22

52 Week Range

$61.25-$74.59

January 16th, 2017

Metro

$9.50B 1.87% 17.1x 2.39 $37.80 - $48.19

Empire

$4.53B (31.25%)

N/A -$8.13 $14.74-27.03

4

QUIC Research Report

January 16th, 2017 Canadian Grocery Market Report ? A Fresh Look on Some Appetizing Investments

Loblaw Holding Considerations

On November 13th, 2013 a position in Loblaw EXHIBIT 4

Companies Limited was added to the portfolio. Net Debt/EBITDA and EBITDA Growth Since then, Shares in the stock have returned 57.8%,

and have retuned 22.6% for the QUIC portfolio.

4.2x

4.5x

$3,000

Although the shares have performed very well

4.0x

relative to the broad market, they have been quite

stale as of late. The primary event causing growth $2,000 since 2013 was the acquisition of Shopper's Drug

Mart, and many of those synergies have already

2.8x

been realized. The purpose of this segment is to $1,000 analyze whether or not Loblaw will continue to be a

2.6x 2.4x

3.5x 3.5x

3.1x 3.0x

2.5x

meaningful holding, or if the team should

trim/remove our position in the company.

$0

2.0x

Reducing Leverage and Increasing Dividends

2011 2012 2013 2014 2015 2016

Net Debt/EBITDA

EBITDA

One primary motive for holding the company is for the possibility of increased dividends. Currently, the company has a dividend yield 1.45%, which is fairly low. Alongside cash and share issuance, Loblaw took on a large debt load of $5.1 billion to finance the Shopper's transaction. While this did not impede on capital expenditure plans, it did reduce the company's ability to return cash to shareholders. However, Loblaw is now an excellent cash flow generator with an FCF yield of 6%, far outpacing the industry. Reducing the Net Debt/EBITDA ratio will create value for shareholders.

Source: Capital IQ

Finding Competitive Advantages

An advantage Loblaw has over its three major competitors, Empire and Metro, is its size. It is by far the largest food retailer with about 2.400 stores and over 70 million square feet of store space. This large presence in the food supply chain delivers pricing power, which is especially important in the current food deflationary environment. Canadian grocers like Loblaw have not lost margins as significantly as their counterparts in the U.S due to their hold on

EXHIBIT 5

TSX:L Share Performance Since Inception

165

157.8

145

125

115.4

105

85 13-Nov-13 13-Apr-14

Source: Capital IQ

13-Sep-14

13-Feb-15 L

13-Jul-15 13-Dec-15 13-May-16 S&P/TSX Composite

13-Oct-16

January 16th, 2017

5

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